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Capital Controls in Emerging Markets Are Worth Watching

|Includes: iShares MSCI Emerging Markets ETF (EEM), SPY

Last week we learned China’s inflation rate jumped by 4.4% while the nation’s president promised to let the yaun appreciate further.  Many investors took this as the death knell of speculation, a sure sign China would raise interest rates significantly.  Commodities traders overreacted, and we saw over $ 100 billion flee the sector on Friday alone.  Nevertheless, a rapid rise in rates is not credible.  While China fears that “hot money” from the Fed’s quantitative easing could flood the country and become a destabilizing influence (and as we have discussed in previous reports, this is a reasonable concern), raising interest rates would only encourage investors to send more money to China to deposit it in higher yielding accounts.

China continues to bubble along with a domestic economy where 8% GDP growth is needed just to employ new entrants in the work force.  In a country whose political leaders have an inbred fear of unrest, options are limited.  We seem to be playing a game where all the kids stare in amazement as one tyke blows and blows a mouthful of gum, bigger and bigger; everyone knows it will pop and make a mess.  That’s why they stare.  

What can China do?  Brazil, Indonesia, and South Korea have all put more limits on capital inflows recently, and it remains realistic for China to tighten its own policies much further.  If investors want to be concerned about something now, they should about this.  Mounting capital controls across emerging markets would represent a sea change event and one worth watching.  


Disclosure: Long SPY